New Guru Kyle Bass co-founded Dallas-based Hayman Woods in 2005 with $10 million of his own money. Previously, he worked as Senior Managing Director at Bear, Stearns & Co., and as a Managing Director at Legg Mason Inc. His fund returned 340% net of all fees in the first four years since inception, including a 216% return in 2007 when he correctly foresaw the downfall of the U.S. sub-prime mortgage market, and a 6% return in 2008, when most investors lost.

Hayman takes a macro view into account in its investment decisions. In his 2008 investor letter, he said, “These returns are the product of many sleepless nights, intense governmental action, and countless discussions among our investment team with regard to our macro views." Currently, he sees the demise of Europe as inevitable and repercussions lasting for months or years. But he believes life, as well as investing, will go on.

Equities

Bass’ portfolio contains 12 stocks with a total value of $739.2 million. Most of the fund is invested in oil & gas, financials and technology. In his investor letter from October 2009, Bass explained, “Our investments are focused on asset-heavy businesses where we can buy into the right portion of the capital structure in advance of the restructuring.”

Bass bought two new stocks in the oil & gas sector in the third quarter. His largest new position, McMoRan Exploration (MMR), is a oil and gas exploration, development and production company focused on the Gulf of Mexico and the onshore Gulf Coast region. It also deals with mining and production of sulfur. Bass bought 1.3 million shares at an average price of $14.17 per share. The stock, which has gone down 6.6% year to date, trades for $16 on Monday.

McMoRan has one of the largest acreage positions in the shallow waters of the Gulf of Mexico and Gulf Coast. For the nine months ended Sept. 30, 2011, McMoRan’s revenues increased to $4.3 billion, from $3.4 billion the first nine months of 2010. It also incurred a diluted net loss more share of $0.55, compared to a net loss of $1.17. The company had $642 million in cash at Sept. 30, 2011 and total debt of $561.6.

His second-largest buy, Imation Corp. (IMN), is in the technology hardware & equipment sector. It develops, manufactures and markets products for color management, imaging and data storage applications, and has a $228 market cap. Imation’s revenues have trended downward for the last three years, and it had profit losses in 2009 and 2010. Free cash flow has remained positive, and more than doubled in 2010 to $143 million, a company record.

The stock has gone down over 40% year to date, and Bass bought 379,320 shares for about $8 per share, building on his position he initiated with 66,093 shares in the second quarter, for a total holding of 1,045,413 shares.

Oil & gas producers he sold out of include Exergy XXI Ltd. (EXXI), Energy Partners Ltd. (EPL) and Apache Corp. (APA). He also exited all of his financials, including all of his Royal Bank of Scotland (RBS) securities and KKR & Co. LP (KKR).

Macro Calls and Japan

Bass believes that Japan is the next country where a crisis will erupt. They spend more than twice what they make, he said in a recent interview at the Darden School of Business. “The way that they finance themselves is that they sell a lot of bonds. And they’ve been able to sell those bonds to their banks, their life cos, their pensions, because they run a big current account surplus.so when you run a big account surprus, that’s new money coming into the system, that new money gets levered in the banking system. What happens is the levered new money buys the bonds to run the fiscal deficit. Well, when your current account dwindles as it does now it’s not sub-3% and your fiscal imbalance is north of 10, you can’t fund yourself anymore. And that’s where they stand at this moment,” he said.

Bass also believes that leaders of the EMU have lost control of the situation and it will not continue to exist in its current form. He sees more countries who contribute to the IMF becoming in need of aid from the IMF, which will exhaust its funds. Investors in sovereign debt are mistakenly believing that hard defaults cannot occur. However, he says in a letter from November 2011 that “financial history has shown repeatedly that waves of default are commonplace across a longer time horizon.”

Unlike doom and gloomers, however, he does not see his thesis playing out as the end of the world, but a temporary disruption.

Japan is different from the countries in Europe. They print their own money. There is no need for them to ever default. I understand that the currency may cheapen but the govt can buy all the bonds if they want and hold rates down. If you really believe in the japan blow up trade then it is a fx trade, not a bond trade.

Tokyojez: I believe that Bass thinks the Yen will strengthen, as money comes back into the country when the events he describes happen. He is not betting on the FX moves themselves. I believe he is betting on interest rate swaps, that the interest rates will not be able to stay low as investors demand more return on their money. A couple of interest rate rises above 0%, and he will be making several hundred percentage returns on the swaps which he believed were mis-priced to not allow for a rate increase. Which makes sense, considering they have gone 20 years with low interest rates, who would think that rates would ever rise? The sellers of these swaps are not pricing in the chance of sudden rate increases. That was my understanding of the trade.

I must correct my comment above. Japan has not had interest rates low for 20 years, only the last 16. You can see it on the historical chart here. [www.tradingeconomics.com]

Prior to 1995, the interest rates ranged from 2% to 8%, so it seems there is some reason to think that the artificially low interest rates might not last.

I believe this is part of a fat tail trade with a tiny part of the portfolio, which if correct would return large double digit returns to the overall portfolio. I believe Hugh Hendry has the same trade on his books.

If the government prints money, you obviously get inflation. This will send the YEN down in value versus other currencies. After the Tsunami, the YEN appreciated considerably versus the dollar, but that was an aberration. Yes, they can print and buy all the bonds they want, but if they are buying all the bonds because no one else wants to buy them, you get hyperinflation like Zimbabwe. Only way to not get inflation is to "sterilize" the bonds, but they cannot do such an operation because they have no other type of bonds or assets to sell that equals 200% of GDP.

With the majority of people who own JGB's wanting to sell, the value will plummet. Culturally and psychologically, JGB's have been the only investment "safe-haven." If that trust is broken its over. And think of all the financial institutions that own the immense number of JGB's on their books. They will become insolvent overnight.

Sadly, in such a scenario, everything in Japan will decline in value considerably. Only companies that do the vast majority of their sales outside Japan will survive and be good investments, but that is after the #@#$ hits the fan. Yes, interest rate swaps are the way to go if you can afford the trade. However, you can also short JGB's (Ticker:JGBS,JGBD), their currency versus the dollar (Ticker:FXY) and their stock market (ticker: EWJ). If Bass is right (and I certainly hope he is wrong, but believe he is 100% right) then, it will be very ugly for Japan for a long time and the Japanese will lose all their wealth, internally and externally.

My apologies for re-posting this, but the crisis probably won't happen soon enough for the shorts to profit. Here's what will delay it:

Japan is super-stockpiling forex reserves by its present interventions to suppress the yen. These will later be spent defending the yen, pushing off the crisis day. The present interventions can be done at ZIRP rates, so Japan piles up a forex warchest for free. The current account will add even more over time. Further yen suppression will, too. These forex reserves now equal over 20% of GDP. These will not eliminate a determined currency assault, but they will delay the effects far longer than people suppose. The longer Japan remains the risk-off haven, the bigger this will swell as the government capitalizes on this win-win forex situation. Extrapolation from the costs of their current interventions, Japan could now sustain a 20 yen/$ boost constantly, for over a year.

Household savings are still 16x the national budget. As they die in ever greater numbers, death/estate taxes channel a big amount of this directly into the national treasury. This alone could alleviate immediate marginal rollover problems instead of worsening them. Politically, the Diet could easily increase this tax and very quickly reap a windfall. It would be much easier than the sales or vat tax, and the Keidanren plus the banks and LDP would be able to force it through, especially by trading concessions to farmers, whose vote is hugely disproportional to the elderly, owing to perennial failure to redistrict.

The budget will certainly cut military spending (greater reliance on U.S. security as we worry about China more) and by increasing the Health co-pay for individuals under the national health insurance. The first is politically very popular, the second is easy via ministerial actions insulated from real democracy. Privatizations of Japan Tobacco, Japan Post, public utilities, etc. will also produce brief windfalls of approximately 2/3 of one year's annual bond dependence.

Most importantly, the rollover crisis will be partially self-correcting. The Government will not intervene until the 135-160 range. At that time, the forex stockpile will be twice as powerful as now, and the longer they wait, the easier intervention will be. Meanwhile, Japan GDP will be skyrocketing as the exporting engine explodes to life. Bank and Ins. Co. balance sheets will show net improvement as overseas carry-trade investments increase in value, easing credit and exerting negative rate pressure. In the 170's, tax revenues would be swelling, current account-driven upward pressure on the yen would be extreme, and the forex warchest spending would be decisive.

Next, the Japanese people have a ridiculous capacity for austerity, legendary obedience, suicidal willingness to support Japan, when asked. If the emperor, for instance, were to ask the people to 'buy bonds' they would.

Also, odds of default are high in countries with external creditors, but politically much harder in countries where sovereign default injures mainly its own nationals. This creates much more political solidarity and appetite for true reform than can has been the case in Greece and Italy, where nationalism is at odds with austerity. In Japan, these forces are in mutual support.

The continual productivity gains combined with Japan's low industrial utilization mean that there is much less domestic demand for investment of national savings, so the savings glut burns off even slower and can more easily be lent to the government in the form of JGB's than would be the case in a healthy economy.

Now, none of these individually eliminates a rollover crisis, but collectively they do push it back, beyond what the costs of a current hedge justify. So, this may still be a widow-maker trade.

Japan has "printed" more money than any other country and have been doing it for over 10yrs. Clearly quantitative easing is not inflationary. It actually is a meaningless exercise as the US is now seeing. It does not increase the wealth of the people. You are just swapping one asset (bonds) for another (cash). There is only one way for Japan to inflate and that is through increasing the budget deficit. I firmly believe that their budget deficit (like the US) is not big enough.
The comments you make above have been made over and over again for the last 10yrs. "Japan's day is just round the corner". Clearly it has not and clearly it is not. Japan govt CAN buy all the bonds, they CAN set the long dated interest rate where they want. That is a fact. They dont need anyone to buy the bonds. Not even the people of Japan need to buy the bonds. The US govt is doing the exact same thing at the moment....buying all their bonds.
Governments who print their money dont actually need to issue bonds to finance their deficit in the first place.

We just heard about Japan offering gold tokens to bond buyers. Why on earth would they do this unless they feel a need to 'advertise' their bonds?

I've heard arguments that a (or even 'the') reason why Japan has survived the last 20 has been due to exports, ie. a world that buys their stuff. If there is a serious enough credit implosion in the west, this consumption would halt. Any comments/objections/estimations on this?

In addition, in Europe it seems interest rate rises are "psychologically contagious". If (if!) interest rates were to go up, would you agree with Kyle Bass analysis then, i.e that the expenses would sky rocket if rates got up only 2%? Or would their FX reserves and the other arguments your list last a substantial while also in this environment?

Disclaimers: GuruFocus.com is not operated by a broker, a dealer, or a registered investment adviser. Under no circumstances does any information posted on GuruFocus.com represent a recommendation to buy or sell a security. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The gurus may buy and sell securities before and after any particular article and report and information herein is published, with respect to the securities discussed in any article and report posted herein. In no event shall GuruFocus.com be liable to any member, guest or third party for any damages of any kind arising out of the use of any content or other material published or available on GuruFocus.com, or relating to the use of, or inability to use, GuruFocus.com or any content, including, without limitation, any investment losses, lost profits, lost opportunity, special, incidental, indirect, consequential or punitive damages. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. The gurus listed in this website are not affiliated with GuruFocus.com, LLC.
Stock quotes provided by InterActive Data. Fundamental company data provided by Morningstar, updated daily.